Crisis management toolkit

Recommendation 5

Complete the existing processes for strengthening crisis management powers that have been on hold pending the outcome of the Inquiry.

Description

In September 2012, the previous Government consulted on a comprehensive package, Strengthening APRA’s crisis management powers.63 The CFR has also recommended separate changes to resolution arrangements and powers for FMI.64 In 2013, these processes were put on hold as part of a Government moratorium on significant new financial sector regulation pending the outcome of this Inquiry. Government should now resume these processes, with a view to ensuring regulators have comprehensive powers to manage crises and minimising negative spill-overs to the financial system, the broader economy and taxpayers.

The Inquiry strongly supports enhancing crisis management toolkits for regulators. It is important for the two processes to be concluded, giving due consideration to industry views on the packages.

Objectives

Promote a resilient financial system.

Enable the orderly resolution of distressed financial institutions.

Discussion

Problems the recommendation seeks to address

Given the importance of ADIs, insurers, superannuation funds and FMI to the functioning and stability of the financial system and economy, regulators need comprehensive powers to facilitate the orderly resolution of these institutions.

Responding to local and global changes, CFR agencies reviewed the existing legislative provisions for prudentially regulated institutions and FMI. These reviews paid close attention to international standards and developments, particularly G20 and FSB initiatives to promote resilient financial systems and frameworks that resolve financial distress, including the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes).65 Although Australia has strong frameworks, the reviews identified gaps and areas that could be strengthened.

The Government consultation paper Strengthening APRA’s crisis management powers canvassed a number of options in relation to all APRA-regulated industries. The package does not include statutory bail-in powers outlined in the Key Attributes or general structural requirements, such as ring-fencing, being pursued in some jurisdictions. It includes:

Directions powers, including clarifying that APRA may direct a regulated institution to pre-position for resolution — that is, require changes at an institution to make it more feasible to successfully resolve that institution if it were to fail.

Group resolution powers, including extending certain powers to authorised non-operating holding companies (NOHCs) and subsidiaries in a range of distress situations.

Powers to assist with resolving branches of foreign banks.

The CFR recommendations for strengthening the crisis management framework for FMI included:

Introducing a specialised resolution regime for FMI.

Clarifying the application of location requirements for FMI operating across borders.

Since these processes were put on hold, international developments have included updates to the Key Attributes, yielding additional guidance on areas such as cross-border information sharing, and resolving FMI and FMI participants. Some countries have also introduced structural reforms, such as mandating a form of ring-fencing, or a NOHC structure for institutions with certain risk profiles or of a certain size, with the aim of improving resolvability. These approaches emphasise reducing risks to core banking activities from more complicated and risky forms of banking, and simplifying institutions to make them more easily resolved.

Conclusion

The Inquiry believes progressing the packages would deliver a substantial net benefit. A range of resolution options — more ‘tools in the toolkit’ — would maximise the likelihood that a viable option will be available in any given situation to achieve an orderly resolution. The Inquiry notes the high costs associated with the disorderly failure of an institution, particularly where this creates financial system instability or the need for Government support. The Inquiry also notes that many of the proposed powers would have a limited regulatory burden in normal times.

In relation to the package of resolution powers for APRA, industry submissions largely support the package, although they raise practical and legal issues with some of the proposals.66

APRA’s submission to the Inquiry stresses the vital role that crisis management powers play in the prudential framework.67 In any future crisis, these reforms would provide a wider range of tools, making it more likely that a credible, low-cost option for preventing a disorderly failure could be found, without risking taxpayer funds.

The RBA advocates for progressing the CFR proposals on FMI regulation as a matter of priority.68 It notes that the continuity of FMI services is critical for the financial system to function. In addition, the RBA notes that, where FMI is domiciled offshore, Australian regulators need to have sufficient influence to prevent Australian functions from being compromised in a resolution.

The Inquiry does not recommend pursuing industry-wide structural reforms such as ring-fencing. These measures can have high costs, and require changes for all institutions regardless of the institution-specific risks. Neither APRA nor the RBA nor the banking industry saw a strong case for these reforms.

Nevertheless, APRA submits that it may be beneficial to require structural changes for specific institutions in some situations, where substantial risks or significant organisational complexity may impede supervision or an orderly resolution. The powers included in the consultation package provide sufficient flexibility to do this effectively.

Given the time that has passed since the initial consultation in progressing the reform packages — in particular, the considerable international developments over this period — a view should be taken as to whether additional proposals warrant inclusion.

All proposals should go through the appropriate consultation, regulatory assessment and compliance cost assessment processes.